Russia Country Report Apr19 - April, 2019

Lower growth in public sector wages and a modest pick-up in inflation bode lower real wage growth. Growth in private consumption will be curtailed by a two-percentage-point increase in value-added taxes at the start of the year. Growth in household borrowing, a bulwark of private consumption over the past two years, should remain high, even if higher on-year growth is unlikely.

If oil prices remain at current levels, the public-sector budget should remain in surplus. The rise in budget revenues will slow and the government’s fiscal rule should limit growth in public consumption. Private consumption in Russia corresponds to roughly half of GDP, while public consumption accounts for just under 20%.

Numerous investment programmes associated with the state-lead national projects are set to get underway in 2020 and 2021. The project spending should slightly boost economic growth, especially in 2020. In contrast, there are no signs of a broad-based recovery in private investment.

The government hopes to attract investment through such measures as subsidising domestic production, increasing domestic-content requirements and guiding large firms to participate in the financing of national projects. The business environment remains burdened by uncertainty and structural problems with the economy. The pick-up in investment growth is likely to be temporary and the economy’s investment rate should remain at just over 20% of GDP.

Substantially higher growth in export volumes relative to import volumes supported economic growth last year. During the forecast period, this gap between export and import growth will narrow. Growth in the state’s overall presence in the economy and lack of market reforms depress the growth outlook in the years ahead.

Russia’s fixed investment was also higher than expected last year, up by 4.3% y/y in 2018 according to Rosstat. The resource sector accounted for the bulk of fixed investment, which has always been the case in Russia. In 2018, the resource industry funded 23.3% of gross fixed investment (24% in 2017) while transport and communications was 19.1%, and manufacturing – 16.7%. foreigner continue to play a small role: 10.8% of the total invested was JVs and 8.3% was from pure foreign investors. However, investment remains far below where it should be if Russia’s economy is to grow at its potential.

But the economy remains resilient, despite all the problems. That was reflected in Moody’s decision to upgraded Russia’s credit rating score by a notch from Ba1 to Baa3 on February 8, its tenth-best rating score. The assessments of all the big three international ratings agencies are now consistent. Standard & Poor’s made a similar upgrade to its rating of Russian sovereign bonds in February 2018, while Fitch never dropped its rating as far, preferring to keep with its BBB- rating in recent years.

The rock solid fundamentals and improving ratings are proving too tempting for bond traders who snapped up the Ministry of Finance Eurobond offers of $3bn and €750mn in March – the largest issue in six years -- with a total volume of $12bn bid. The US Fed decision to stop tightening has put investors into “risk on” mode and the equity market is also up by 16% YTD with some sectors like banks up 20% as interested in Russian stocks returns.

But the threat of more sanctions still hangs over the market. What the DAKSAA sanctions will look like in their final form is still unknown and the issue wont be resolved until sometime in April. However, the Mueller report’s decisive blow to the Russiagate collusion accusations can only improve sentiment.

Moody’s praised the Russian government for implementing prudent fiscal policies, but at the core of these policies is the accumulation of foreign currency into the National Welfare Fund and insulating Russia’s assets from the reach of sanctions – essentially a war mentality. With the emphasis of safety over prosperity, the state is unwilling to leverage itself in order to deliver growth closer to potential.

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